Regulatory-Optimal Funding

Funding is a cost to trading desks that they see as an input. Current FVA-related literature reflects this by also taking funding costs as an input, usually constant, and always risk-neutral. However, this funding curve is the output from a Treasury point of view. Treasury must consider Regulatory-required liquidity buffers, and both risk-neutral (Q) and physical measures (P). We describe the Treasury funding problem and optimize against both measures, using the Regulatory requirement as a constraint. We develop theoretically optimal strategies for Q and P, then demonstrate a combined approach in four markets (USD, JPY, EUR, GBP). Since we deal with physical measures we develop appropriate statistical tests, and demonstrate highly significant (p<0.00001), out-of-sample, improvements on hedged funding with a combined approach achieving 44% to 71% of a perfect information criterion. Thus regulatory liquidity requirements change both the funding problem and funding costs.Comment: 20 pages; 8 figures; 2 tables, Risk, April 201

Do jets precess... or even move at all?

Observations of accreting black holes often provoke suggestions that their jets precess. The precession is usually supposed to result from a combination of the Lense-Thirring effect and accretion disc viscosity. We show that this is unlikely for any type of black hole system, as the disc generally has too little angular momentum compared with a spinning hole to cause any significant movement of the jet direction across the sky on short timescales. Uncorrelated accretion events, as in the chaotic accretion picture of active galactic nuclei, change AGN jet directions only on timescales \gtrsim 10^7 yr. In this picture AGN jet directions are stable on shorter timescales, but uncorrelated with any structure of the host galaxy, as observed. We argue that observations of black-hole jets precessing on timescales short compared to the accretion time would be a strong indication that the accretion disc, and not the standard Blandford-Znajek mechanism, is responsible for driving the jet. This would be particularly convincing in a tidal disruption event. We suggest that additional disc physics is needed to explain any jet precession on timescales short compared with the accretion time. Possibilities include the radiation warping instability, or disc tearing.Comment: 4 pages. Accepted for publication in ApJ Letter

Estimating returns to education: three natural experiment techniques compared

Andrew Leigh and Chris Ryan compare three quasi-experimental approaches to estimating the returns to schooling in Australia: instrumenting schooling using month of birth, instrumenting schooling using changes in compulsory schooling laws, and comparing outcomes for twins. Abstract With annual pre-tax income as our measure of income, we find that the naïve (OLS) returns to an additional year of schooling is 13%. The month of birth IV approach gives an 8% rate of return to schooling, while using changes in compulsory schooling laws as an IV produces a 12% rate of return. Finally, we review estimates from twins studies. While we estimate a higher return to education than previous studies, we believe that this is primarily due to the better measurement of income and schooling in our dataset. Australian twins studies are consistent with our findings insofar as they find little evidence of ability bias in the OLS rate of return to schooling. Our estimates of the ability bias in OLS estimates of the rate of return to schooling range from 9% to 39%. Overall, our findings suggest the Australian rate of return to education, corrected for ability bias, is around 10%, which is similar to the rate in Britain, Canada, the Netherlands, Norway and the United States

CDS pricing under Basel III: capital relief and default protection

Basel III introduces new capital charges for CVA. These charges, and the Basel 2.5 default capital charge can be mitigated by CDS. Therefore, to price in the capital relief that CDS contracts provide, we introduce a CDS pricing model with three legs: premium; default protection; and capital relief. If markets are complete, with no CDS bond basis, then CDSs can be replicated by taking short positions in risky floating bonds issued by the reference entity and a riskless bank account. If these conditions do not hold, then it is theoretically possible that the capital relief that CDSs provide may be priced in. Thus our model provides bounds on the CDS-implied hazard rates when markets are incomplete. Under simple assumptions we show that 20% to over 50% of observed CDS spread could be due to priced in capital relief. Given that this is different for IMM and non-IMM banks will we see differential pricing?Comment: 16 pages, 10 figues, 3 table

AGN Flickering and Chaotic Accretion

Observational arguments suggest that the growth phases of the supermassive black holes in active galactic nuclei have a characteristic timescale $\sim 10^5$ yr. We show that this is the timescale expected in the chaotic accretion picture of black hole feeding, because of the effect of self-gravity in limiting the mass of any accretion disc feeding event.Comment: 3 pages. Accepted for publication in MNRAS Letter